‘Order’ Your Broker to Enter Trades Cheaper

by Dawn Pennington | August 21, 2008 12:57 pm

‘Order’ Your Broker to Enter Trades Cheaper

The great thing about options trading is that you really don’t have to be glued to your computer screen, watching and waiting for a put or call that you want to buy or sell to reach a recommended price level.

Of course, you could do that if you want to get a feel for how that option behaves on a particular day. But if a trading idea comes your way after the market has closed — for instance, to buy a particular option up to $1 — no doubt you’ll want to try to jump right into that trade when the market opens the following morning.

GIVE YOUR BROKER HIS MARCHING ORDERS …

Given that it’s not always possible to catch that ideal entry price due to things like meetings and doctor’s appointments and other life events that keep you away from your broker’s Web site, the options markets offer a variety of order types that allow you to leave execution instructions with your broker to initiate a trade when one or more trading conditions are met.

One such type is a market order, which means your broker will fill the order at whatever the market price is when the instruction is received.

If you want to be a little more cautious — given that options can move much faster than stocks — you can place a limit order, which enables you to set an order to be filled at a particular price or better.

There’s no guarantee …

… that your order will be filled, but if the market price meets or beats your criteria (e.g., “buy X option at $1), it means that if the option trades at 95 cents before it climbs to $1 while the order is active, then you will get into the trade at 95 cents. However, your trade will not be filled if the option never trades below $1.05 for the life of the order.

One order type that I typically caution against is the “at-the-opening” order (or “opening only” order), which specifies that your trade is to be executed at the start of the trading day; otherwise, it’s canceled.

Let’s say that you want to get into that option trade at $1, but the trading range at the open is between $1.20 and $1.30. Not only will your order not be filled, but it will be canceled immediately because the prices weren’t “right” at the open. However, if that option opens between 95 cents and $1.05, then your order will indeed be filled.

PLACE YOUR ORDERS LIKE A PRO

You can use any of these or other types of orders when you’re initiating a stock position, too. But especially in regard to the last strategy, I want you to keep in mind that an opening-only order can be like opening your wallet and saying, “Please take my money!”

It hurts a lot less when you get into your option trade …

… at an opening price $1 and the thing goes down to 85 cents half a day later than when you buy a stock at $30 and it takes a similar 15% hit, leaving you holding shares almost five bucks below where you bought them.

The first hour of trading is frequently referred to on the trading floor as “amateur hour” — that is, if the market gets a running start to the day because some blue chip company exceeded earnings before the opening bell, you could end up paying a lot more than is necessary for a hot stock that cools off to a more attractive price point later in the day!

HOW MUCH IS TOO MUCH TO PAY?

As with any strategy you use, be sure to implement a sell stop so that no matter what happens with the trade once it’s yours, mastering the trading game will feel more like a game and less like a stressful endeavor.

When you’re looking up an options quote[1], you’ll see a number of prices — the most recent price, the bid price and the asking price (which is also called the “ask” or the “offer price”).

The price of the most recent trade can be deceiving, for two reasons. One, if you’re looking at option prices online, the figures may delayed by 15 to 20 minutes and therefore do not accurately reflect what might be happening at that very moment. Secondly, the price itself can be sort of a misnomer, as the most recent trade that took place could have been 15 minutes or 15 DAYS ago!

To get the best reflection of how an option is trading …

… you can look at both the bid and the ask prices. Every option available for trading has both of these.

Traders typically buy on the bid price and sell at the asking price. The bid/ask spread, then, is the highest price a buyer wants to pay for an option and the lowest price a seller is willing to accept for it.

Market-makers are the ones who set the width of the spread, so it can be anywhere from a few cents to a few percentage points, depending on the asset’s value.

These dealers work independently of brokerages and they match up buyers and sellers by handling the buy and sell orders. This involves taking on a great deal of risk but serves to ensure that your orders are not only filled (if the conditions can be met), but also protected.

To learn more about options pricing, read Dawn Pennington’s “Market-makers Can Make or Break Options Trades”[2] and Ken Trester’s “The Price of Options Trading Success.”[3]

The Options Trader’s Guide to Technical Analysis – Learn how to leverage the power of technical analysis to identify the short window when a trade is set to go straight up or down. Get your FREE copy here![4]

Endnotes:

looking up an options quote: http://www.optionszone.com/getaquote//index.html

“Market-makers Can Make or Break Options Trades”: http://www.optionszone.com/learn-more/dawn-pennington/market-makers-can-make-or-break-options-trades-dp.html